Over the past few days the Forex world has been rocked by the wild, sudden rise in the Swiss Franc last Thursday, which eventually stabilised at a gain of about 15% against all the major currencies. We’ve all got questions about how and why this happened, and what it means, so let’s try to answer them.
Q: What actually happened last Thursday?
A: The SNB (Swiss National Bank) made an announcement that caused the CHF (Swiss Franc) to suddenly soar in value. The extent and speed of the price rise had never happened before to a major global currency, although there were similar incidents involving the CHF in 2011 and the GBP (British Pound) in 1992. The size and speed of the change meant that most banks effectively stopped buying or selling the CHF for several minutes, which had all kinds of bad effects (more on that later).
Q. What was it exactly that the SNB announced?
A. The SNB announced that they were no longer going to support a cap of the value in the CHF against the Euro. For more than 3 years, they would intervene to make sure the CHF was worth no more than 1.2 Euros. It is relatively easy for a central bank to keep their own currency weak, but it was getting harder for them to do it, as the price kept testing 1.20 and the Euro has been weakening dramatically over several months. The SNB announcement took the market by surprise, as although there was a logical risk this could happen, as recently as a few days ago the SNB publicly declared that they had no intention of abandoning the policy, which now can be seen to be a clear lie. By the way, the SNB also announced a negative interest rate of 0.75%, meaning depositors have to pay for the privilege of holding deposits in CHF. This would usually tend to weaken a currency, at least in the short term.
Q: Why did the SNB Abandon the Cap?
A: There are different interpretations of the SNB’s action so all explanations are controversial. They said that they no longer feel the CHF is as overvalued as it was, so maybe they did not feel that they had to hold the market back so much. However they have also said that they did not expect the CHF to rise by 15% right away. A deeper explanation would be that with the recent strong fall in the value of the Euro, which is by far the currency most strongly linked by trade to the CHF, it was becoming increasingly difficult and expensive for the SNB to keep the CHF as weak as the Euro, so they acted to abandon a position that was becoming untenable. Many have speculated that the SNB were expecting the ECB (European Central Bank) to announce a program of Quantitative Easing (QE) later this week, which might well push the value of the Euro down even further, and at a rapid rate. If the cap had still been in effect, they would probably have had to have spent a lot of their reserves buying Euros with CHF.
Q: What will it mean for the price of the CHF going forward?
A: It is hard to say. Usually when the value of a currency moves strongly up or down quite quickly by this kind of amount, it continues to move in the same direction for a few more weeks or months at least. However, there is some feeling that the move has gone far enough, and that the SNB might act to cap the CHF again at the latest market price, so it may not continue to increase. In any case, it is quite likely that in the short-term, the CHF will swing up and down with high volatility.
Q: What will it mean for the prices of other currencies?
A: The move on Thursday seemed to cause some volatility in other currencies, but that has gone at the time of writing, with nothing but the CHF moving by very much. It could be argued that now that cash can flow into the CHF, it might weaken the rise of the USD a little.
Q: Why did Forex traders and brokers lose so much money?
A: Usually, currencies fluctuate in value by very small amounts, far less than stocks, for example. The Forex market is also usually extremely liquid. This means that traders can place tight stop losses and trade with high margin, in the knowledge that if their stop loss is hit, they will usually not have to pay any slippage. Unfortunately in this kind of case, the price blew right past almost every stop loss without stopping, so traders and brokers could not execute any trade exits until the price of all CHF pairs had moved by far more than 1,000 pips. This meant that instead of exiting at stop losses such as 50 pips of loss, emergency exits had to be made at more than 1,000 pips or more. With leverage, most traders in any kind of short CHF trade would have had their entire deposits wiped out. In fact, many traders suffered losses beyond that, and are now facing negative account balances, which brokers may or may not be able or willing to chase. As for brokers losing money, there are two reasons for this: some brokers hedge their clients’ trades in the real market, where they also experienced the same problems even more strongly than their own clients did, meaning they could not pass on their clients’ losses. The second reason is that anyone who was in a long CHF trade with a broker, would have made a lot of money, and the balance of these trades may not have been covered by the losses of the losers, as the losers would have mostly negative account balances.
Q: So I can end up owing my broker more than I deposited with them?
A: Yes, although it is very rare for this situation to happen. Some brokers do state that they will never pursue a client for a negative balance, as they consider it to be a fault of their own risk management procedures if it happens (e.g. FXCM). Other brokers, such as Oanda, have announced that they will forgive any negative balance. However there are unconfirmed reports of certain brokers writing to clients demanding they make good large negative balances. Some brokers, for example Saxobank, have actually stated that they may “re-quote” client’s closed CHF trades to the detriment of the clients’ positions.
Q: What about my broker? Will brokers go out of business?
A: You should get in touch with your broker if you are concerned about the situation. It is too early to say if any brokers will go out of business, but without doubt, many brokers have suffered heavy losses.